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Central Banks: Flush With Paper Money; Low on Real Money

By: GoldMoney | Thursday, January 31, 2013

The Gold Money Index, created by James Turk, is a simple but logical formula.
It treats central bank gold reserves as international money - the world's true
and only reserve currency, if you will - and compares said gold reserves against
central banks' fiat currency reserves.

At first glance this treatment of gold might sound unorthodox, but nothing
could be further from the truth. For instance, under the Bretton Woods Agreement
of 1944, international central banks trusted the US dollar because, after it
was received for international commerce, it could be presented back to the
US and redeemed for a designated amount of gold. Hence it was gold, not (paper)
dollars that settled the balance of payments between nations and their respective
markets.

History would show, however, that the United States government could not keep
its "golden promise". In 1971, with numerous foreign central banks turning
in their US dollar reserves for gold, the United States closed "the gold window" and
ceased redeeming US dollars for gold. Since then, the dollar has been paper
money.

As international trade has grown, so have international payments. Foreign
central banks now hold over $10 trillion dollars' worth of foreign currencies.
60% of those reserves are held in US dollars and dollar-denominated securities.
The reason for US dollar dominance is simple: since Bretton Woods the dollar
has been the undisputed world reserve currency, meaning that it is the settlement
currency of choice for all manner of commercial activities around the world
which may or may not have anything to do with America or Americans. A Russian
supermarket might arrange a deal to import wine from Chile; they will pay the
Chileans in US dollars - not pesos or rubles. When you buy gold with GoldMoney,
even if your are using a currency other than the US dollar to fund the purchase,
that currency will first have to be converted into US dollars for GoldMoney
to buy your metal.

There is however a contradiction, identified by Belgian economist Robert Triffin
in the 1960s, between the world's need for a liquid reserve currency - which
requires America to run persistent trade deficits - and the long-term health
of the dollar. Constantly running trade deficits weakens the dollar and so
causes the countries that are accumulating an ever-greater mound of greenbacks
to look for alternate means of preserving their wealth. Reserve-currency status
carries with it the seeds of its own destruction.

This is the situation we are faced with today. Surplus nations around the
world are up to their eyeballs in US government liabilities. But the Federal
Reserve is determined to devalue the dollar in order to promote economic recovery
in America. So these countries - notably China, owner of some $3 trillion in
dollar-denominated reserves - are faced with the prospect of seeing their hard-earned
wealth frittered away by the Fed's printing press.

So they're looking to "get out of Dodge" by exchanging their dollars for other
assets - notably gold. According to official statistics, just 1.6% of China's
$3 trillion foreign exchange reserves are allocated to gold. The world average
is 14.4%. So the Chinese need to (and are) doing a lot of buying in order to
close the "gold gap".

So how high can we expect gold to go as a result of buying from China and
elsewhere? The Gold Money Index might provide us with an answer.

The "fair price" of gold today

As one might venture, the fair price of gold remains well above the current
spot price. According to current statistics from the International Monetary
Fund, the Currency Composition of Official Foreign Exchange Reserves (COFER) -
that is, the total holdings of official foreign currency at central banks -
has increased to over $10 trillion USD ($10,778,740,000,000 to be exact). Conversely,
central bank holdings of gold currently stand at just 31,575 tonnes.

Plug both these figures into the Gold Money Index formula ($10,778,740,000,000
of currency divided by 31,575 tonnes of gold) and you arrive at a fair price
of $10,617 per ounce.

As central banks and individuals seek to increase their allocation to gold
as the US dollar steadily devalues, we can expect gold to surge from present
levels. All the way to $11,000? Perhaps. Only time will tell.

For more information, and to arrange interviews, please call Gwyn Garfield-Bennett
on 01534 715411, or email gwyn@directinput.je

GoldMoney is one of the world's leading providers of physical gold,
silver, platinum and palladium for retail and corporate customers. Customers
can trade and store precious metal online easily and securely, 24 hours a day.

GoldMoney customers hold almost 21 tons of gold in storage worldwide, and
own a combined total of US$1.6 billion in precious metals.

Historically gold has been an excellent way to preserve purchasing power
over long periods of time. For example, today it takes almost the same amount
of gold to buy a barrel of crude oil as it did 60 years ago which is in stark
contrast to the price of oil in terms of national currencies such as the US
dollar.

GoldMoney is regulated by the Jersey Financial Services Commission and complies
with Jersey's anti-money laundering laws and regulations. GoldMoney has established
industry-leading governance policies and procedures to protect customers' assets
with independent audit reporting every 3 months by two leading audit firms.

GoldMoney has its headquarters in Jersey and also has offices in London and
Hong Kong. It offers its customers storage facilities in Canada, Hong
Kong, Singapore, Switzerland and the UK provided by the leading non-bank vault
operators Brink's, Via Mat, Malca-Amit, G4S and Rhenus Logistics.